Getting a great interest rate takes more than you might realize.
So, you’re shopping for a home and you need a mortgage. You’ve gone online and looked at sites like, www.bankrate.com and www.lendingtree.com and you’ve determined that you should be getting an interest rate of 5.625% for a 30 year fixed rate mortgage. After all, the website said so! What’s missing from this story are three very important components of your specific situation (and what you have to pay for that rate. We’ll cover that in a later article). These components are your credit score, loan purpose, occupancy, number of units, product type, etc. All of these are important but your credit score or FICO, the size of the loan you need and how large that loan is relative to the value of the home (also known as, the Loan-to-value ratio) that is the starting point for a rate discussion. Below, we’ll look at each of these three specific components, one at a time. When I have explained each component, we’ll then come back to the underlying topic of this article, Fannie Mae’s Loan Level Price Adjustments.
Before we go there, Fannie Mae or the Federal National Mortgage Association (FNMA) is a government sponsored entity (GSE) that was set up after the great depression to expand the market for mortgage loans. Fannie does this by creating a multiplier effect allowing lenders to reinvest their assets after selling the home loans. The buyer? The federal government and they buy in the form of mortgage backed securities. Fannie Mae has a brother named, Freddie Mac or the Federal Home Loan Mortgage Corporation (FHLMC). They operate as a GSE also. Each GSE has guidelines that lenders and banks must follow if they want to have their loans purchased. Ok, enough history, let’s get into it.
FICO. Knowing what your credit score is the very first step to understanding your credit rating and how it impacts your ability to get credit. Most borrowers that I speak to will tell me, “Oh, I have a 780 score,” and when I ask how they know, they say, “My (enter the name of your favorite credit card) gives me my credit score every month.” That’s perfect. The number that you get from your credit card company is a great start, but it won’t be the score I or any other lender will get to use. When we submit your loan application to the bank for approval, we’ll use another source and that source will look at three scores! The FICO we must use comes from a credit reporting agency that queries each of the three credit bureaus (Equifax, Experian and TransUnion). Yeah, I know, agency, bureau, what’s the difference?
A credit reporting agency is a company that works with companies that extend credit to borrowers to get regular updates on your payment history. There a many, many of these companies. The credit reporting service then regularly delivers your payment history to the credit bureau with which they have an agreement. Big companies like American Express or Visa have agreements will all three bureaus (Experian, Equifax and TransUnion). Some smaller creditors (those businesses who extend credit) may work with a credit reporting service that only works with one of the bureaus. So, when they report your payment history, it may only get reported to one bureau. Does this mean that you don’t have to worry if the vendor you paid late or not at all only reports you to one bureau? Nope. Always protect your credit rating, no matter who you use to established credit or payment terms. The easiest way to do that is to pay your bills on time. Simple.
Here’s how mortgage lenders see your credit when they submit your loan application. They also use a credit reporting agency. Again, there are many. That agency then queries all three bureaus to determine what your credit history looks like and each will issue a score based on what information they have about your payment history. So, here’s an example:
John Robert Borrower (JRB) is going to apply for a home loan. He completes his application and gives the mortgage lender permission to pull his credit history. The lender asks its credit reporting service to issue a “Tri-Merged” report (“Tri” for the three bureaus and “merged” for you guessed it, a merged report) for JRB. The report comes back and shows that Equifax gives him a 707, Experian gives him a 715 and Transunion gives him a 739. When we go to determine JRBs credit worthiness for a home loan, we are going to use the middle score of these three as his official credit score. In this example that would be 715. This is the first of the Loan Level Adjusters we’re looking at today. Let’s look at the next two.
Loan size. Is that your loan or are just happy to see me? Ok, ok, I know. Lame. These are the jokes, people. But size DOES matter. I know. I just can’t help it. In all seriousness though, the size of the loan will impact your interest rate. Huh? Let’s break it down.
Fannie Mae is a GSE that buys loans from mortgage banks and traditional banks. Fannie Mae sets the conforming loan limits for all counties nationwide. They determine what the conventional conforming and high-balance loan amounts are for each county. Here in the San Francisco Bay Area, those limits are as follows; up to $726,200 is considered a conventional conforming loan. From $726,200 to under $1,089,300 is considered conventional high-balance. Any loan larger than $1,089,3000 is considered a jumbo loan. There are loans that are larger than $1,500,000 that some call super jumbos, but we won’t cover those as they are beyond the scope of this article. And that’s all I have to say about loan sizes. For now.
Loan to Value Ratio. The last of the levers that we need to discuss is Loan to value ratio (LTV). Essentially, this is the ratio of your loan size to the appraised value of your home. So, once again, size matters. When we buy a home most of us have been told that we need to have 20% down. This means you have a loan to value ratio of 80%. The more money down, the lower your LTV is going to be. Oh, and if you happen to have less than 20% to put down, there are programs out there to help you with down payments and that will allow less than 20%. So, don’t count yourself out if you don’t have 20% to put down. Look for my contact info at the end of this article. When you reach out, we can go over your options.
Once you have purchased your dream home, we hope that it will appreciate. Here in the SF Bay Area, we unprecedented appreciation over the past few years. Amazing, right? It would be hard to plan on that appreciation continuing at the same pace but stranger things have happened with California real estate. As they say in any investing prospectus, past performance is no guarantee of future gains. Plan accordingly. There it is. LTV. The final component in our complicated equation.
So, now that we know there are three components to deriving what your rate will be and we know a little bit more about each one, let’s explore how they come together. To do this, we need to create another borrower. Earlier in the article, we met John Robert Borrower. JRB had a middle credit score of 715, which is OK but now we’ll meet Patricia Perfect. Patty has a middle credit score of 741. This places her in lowest risk category, according the Fannie Mae guidelines. A borrower with a credit score of higher than 740 happens to fall into the lowest risk category. Does each LLPA have a lowest risk category? Why yes, I’m glad you asked.
In addition to the credit score, we also need to be looking at the loan size. Any loan that is smaller than the conforming loan limit of $726,200 here in San Francisco Bay Area also falls into the lowest risk category.
The final risk category is the loan to value ratio or LTV. Any loan that has an LTV of less than 60% lands in the lowest risk category.
So, there it is. FICO of 740 or higher, loans that fall into the conforming category and have an LTV of less than 60% are going to get premium rates. There are other ways to get great rates too but again, that is beyond the scope of this article.
One final note. Today, we are talking about owner occupied, single family detached residences. If we use these three criteria to determine interest rates for the purchase of this type of home, we can be pretty certain that we’re going to get an accurate rate and APR quote. So, again, typically, the best rates go to those borrowing less than the conforming loan limit of $726,200 here in the SF Bay Area, where the loan to value ratio is lower than 60% and where the middle credit score is higher than 740. By the way, if you and someone else (like your spouse, sibling or even a friend) are both on the loan application, we’re going to use the lowest middle score from either of you. So, if JRB and Patty are married or going in the same purchase, we’ll need to use JRBs score of 715, not Ms. Perfect’s 741.
Hopefully, this makes sense. You can post your questions here or email me directly. Are you currently looking to buy a 2, 3, or 4-unit home, second or vacation home, investment property or take cash out for home repairs or debt consolidation? Fannie Mae has additional Loan Level Price Adjustments that will be applied to these types of loans. Do you want an exact rate quote and phenomenal service? Contact me at chris@yourlenderchris.com
Sources
https://www.fanniemae.com/content/pricing/llpa-matrix.pdf
https://en.wikipedia.org/wiki/Government-sponsored_enterprise
https://en.wikipedia.org/wiki/Bibliography_of_Fannie_Mae_and_Freddie_Mac
https://www.usa.gov/credit-reports#item-35962
https://www.doughroller.net/credit/which-fico-scores-do-mortgage-lenders-use/
https://www.fhfa.gov/DataTools/Tools/Pages/Conforming-Loan-Limit-Map.aspx
https://www.hud.gov/states/california/homeownership/prgmscounty